Month January 2011

‘Any argument that a pad is not a PC is simply out of sync,’ said Chiam. ‘With screen sizes of seven inches or above, ample processing power, and a growing number of applications, pads offer a computing experience comparable to netbooks. They compete for the same customers and will happily coexist. As with smart phones, some users will require a physical keyboard, while others will do without.’

‘Each new product category typically causes a significant shift in market shares,’ said Chiam. ‘Apple is benefiting from pads, just as Acer, Samsung and Asus previously did with netbooks. The PC industry has always evolved this way, starting when Toshiba and Compaq rode high on the original notebook wave.’

The iPad and iPhone came, saw and conquered new markets. But since the products launched the question on every analyst’s mind has been on how much have these products “cannibalized” their brethren the iPod and the Mac.

This notion of “cannibalization” applies when a product is designed to compete and “eat” the share of another product in a company’s portfolio. It has some negative connotations since it implies loss but many times the thinking is that it’s better to cannibalize oneself rather than have it done by a competitor.

The gross margin percent, which measures the direct or variable costs of production vs. price, shows a healthy rise in the last five years from slightly below 30% to around 40%. The Operating Margin, which also includes the overhead or fixed costs like R&D and SG&A, shows a similar rise, reaching about 30%.

Margin expansion while sales quadruple is a good indicator that a company is producing real value not just trading sales volume for profit.

Apple set a new record for Mac sales in the fourth quarter. This was not a surprise. The growth was perhaps a bit lower than some expected (including me) but it was still a healthy 23% and 8x the PC growth rate. The Mac has outgrown the PC (and hence has gained share) for 19 quarters straight, nearly five years.

What’s more interesting is where the growth came from. Every region outgrew the market. Asia-Pacific led with a 67% year-over-year increase, almost 10x the market. Japan grew at 56%, which is about 6x the market, and Europe and the United States both grew in double-digits despite both markets contracting overall.

Looking over a longer time frame, the Mac has nearly quadrupled in volume in five years. In the last quarter of 2005, Apple sold 1.2 million units. In the latest quarter it sold 4.1 million. So the performance has been relatively good.

One significant reason for the growth has been the shift from desktop to portables. The lines show how the percent of portables went from about 50% to 70% of units and sales in four years.

Those rumors were quashed, but we now know there is something to them.

During the September and December quarters, we executed long-term supply agreements with three vendors through which we expect to spend a total of approximately $3.9 billion in inventory component prepayments and capital expenditures over a two-year period. We made approximately $650 million in payments under these agreements in the December quarter, and anticipate making $1.05 billion in payments in the March quarter.

We expect revenue to be about $22 billion, compared to $13.5 billion in the March quarter last year. We expect gross margins to be about 38.5%, reflecting approximately $50 million related to stock-based compensation expense. We expect OpEx to be about $2.35 billion, including about $250 million related to stock-based compensation. We expect OI&E to be about $50 million, and we expect the tax rate to be about 25.5%. We are targeting EPS of about $4.90.

This is a particularly aggressive revenue growth forecast of 63% (note again that Apple’s P/E has dropped to 18 and 14 ex cash and 10 on a forward basis) . Since Apple always guides very conservatively, the likely figures for the top and bottom lines are likely to be higher.

How much higher? Here are my estimates (growth in parentheses is year over year).

iPhone units: 18.4 million (110%)

Macs: 3.62 million (23%)

iPads: 6 million

iPods: 10.1 million (-7%)

Music (incl. app) rev. growth: 25%

Peripherals rev. growth: 23%

Software rev. growth: 23%

Total sales: $24.5 billion (82%)

GM: 38.8%

EPS: $5.89 (77%)

Looking a bit further ahead, earnings suggest the company is now trading at a forward P/E of about 9.5.